Billions lost in tax revenue

The time has come for us to change and embrace the digital economy in all its fullness and make it work for us 

While, these foreign companies are not breaking any Sri Lankan law currently as there is no tax evasion per se, there is a necessity to bring them into the mainstream of the economy, so that they could become a part of a vibrant, super competitive space that will help local startups to pitch themselves against global giants, and bring their services on par with international standards. This is a win-win for all as global companies will then align themselves with the economies they operate within. As for the Government, there is the additional tax revenue, and the local startups get to compete on a level -playing-field with global operators

• Do we need a Multinational Anti Avoidance Law in Sri Lanka?

What would be your reaction if I say, the Government can earn another Rs. 10 to 20 billion in taxes annually, just by tweaking our existing laws to bring global digital companies operating in Sri Lanka under the local tax net? This number is not something I came up with at will, but is based on a calculation made recently, by a group of local digital company heads who were gathered in my office for a meeting. In fact, 10-20 billion is a notional figure I considered more conservative for the purpose of this article. The number the industry leaders came up with was a lot more.

Access to information and transparency

While the above insight came up as part of a discussion between industry leaders, it led to the startling realisation of the necessity for Government bodies and policymakers to act now, in coming up with frameworks to get both local and offshore digital companies to disclose the actual scale of their business revenues. This level of transparency is an absolute must in a data driven global economy, where critical information supports better governance. 

Can this be done without international agreements? 

I stumbled upon a recent article written in the Australian Financial Review that captured how Australia had done this successfully. In 2016, they brought in a regulation called the Multinational Anti Avoidance Law (MAAL), which made it possible. Australia too faced challenges initially, with global digital companies operating within their shores, moving their revenues to safe havens in other countries. But the Australian Tax Office (ATO) was able to buttonhole these companies and bring them to book under the MAAL. Millions of dollars were paid back to the ATO in backdated taxes by these global companies, who have reorganised their organisational structures to work within the Australian tax laws. 

Learnings for Sri Lankan tax authorities from Australia

The MAAL, incorporated in 2015 is a part of the Australian government’s efforts to combat tax avoidance by multinational companies operating in Australia and applies to certain schemes on or after 1 January 2016, irrespective of when the scheme commenced. Broadly, the law applies to:

A foreign entity supplies goods or services to an Australian customer

An Australian entity, that is an associate of or is commercially dependent on the foreign entity, undertakes activities directly in connection with the supply

Some or all of the income derived by the foreign entity is not attributable to an Australian permanent establishment, and

The principal purpose, or one of the principal purposes of the scheme, is to obtain an Australian tax benefit or to obtain both an Australian and foreign tax benefit.

Making global operators accountable to pay taxes

Going by the Australian Financial Review article by senior writer Neil Chenoweth, these multinational companies devised ways to bypass the Multinational Anti Avoidance Law (MAAL). 

For example Facebook, initially set up a separate venture, FCL Tech Australia, owned by FCL Tech Ltd in Ireland, an approach claimed to appear consistent with an anti-MAAL scheme described by the Australian Tax Office (ATO) to avoid the MAAL. But they later became compliant, settling for $ 31.3 million on 13 October 2017 with the ATO for disputes covering 2009 to December 2016.

Tax exemptions and competing with global peers

It is relevant to talk about tax and the digital economy at this point in time because with the budget round the corner, crucial decisions are being discussed in respect of various industries. Traditionally, tax exemptions have been given to ecosystems which are considered nascent and require nurturing. Many industries have benefited from this, some going from fledgling status to become industry giants. The IT industry is one such, to enjoy tax exemptions, leading it to become successful. However, within this vast sector there yet remains a niche that requires immediate care and nurturing i.e. the startup sector. This is an area that requires careful consideration, not only in terms of whatever support the Government can give in regard to tax exemptions, but also from the point of view of creating a level playing field for local digital operators to compete with their global peers. 

Taxing global digital operators is a big discussion internationally but no one has come to any agreement about it. The OECD and the United Nations are all involved in the discussion, but a consensus is yet to be reached.

How can Sri Lanka benefit?

In the past, we thought there was no provision in Sri Lanka’s tax statutes to subject non-resident companies engaged in virtual businesses in the country to domestic taxes. However, according to opinions of tax experts, such non-resident companies engaged in virtual businesses, are liable as per the existing tax statutes, to pay income tax on their business income and indirect taxes on their turnover. Following are the grounds on which this opinion is based:

Income Tax on business profits: Non-Resident Companies can be made liable to pay income tax on profits because of their Permanent Establishment (PE) based on the Agency PE. (Relevant provisions are: Sections 75 and 76 (2)(a) of the Inland Revenue Act, No.24 of 2017 and Para 5 & 7 of Article 5 and Article 7 of the Double Tax Avoidance Agreements of the UN Model, which Sri Lanka mostly adopts.

http://www.ird.gov.lk/en/publications/Acts_Income%20Tax_2017/IR_Act_No._24_2017_E.pdf (Page 66-67)

Sales Tax on the Business Turnover: VAT can be imposed on such Non-Resident companies or on their agents that are carrying on their taxable supplies in Sri Lanka. (Please refer to the relevant sections 2(1)(a), 55(1) &(2) of VAT Act No 14 of 2002.

http://www.ird.gov.lk/en/publications/Value%20Added%20Tax_Acts/VATActNo14[E]2002.pdf (Page 01 & 53)

Creating a level playing field for Sri Lankan companies

It must be made mandatory for foreign digital companies to register in Sri Lanka — not just as their onshore arm but as a subsidiary or an agent in the country who collects all of their revenue and pays designated taxes. We can’t have our local suppliers of goods and services entering into contracts generated outside the country, enabling foreign operators to syphon our money in valuable dollars. This is unfair because they use local infrastructure like road and telecommunication networks, state administration like the police, health services, customs, logistical support, etc. which is all paid for by locally registered taxpayers. Therefore it is logical that foreign digital companies are treated as equal under the law for local taxation.

While, these foreign companies are not breaking any Sri Lankan law currently as there is no tax evasion per se, there is a necessity to bring them into the mainstream of the economy, so that they could become a part of a vibrant, super competitive space that will help local startups to pitch themselves against global giants, and bring their services on par with international standards. This is a win-win for all as global companies will then align themselves with the economies they operate within. As for the Government, there is the additional tax revenue, and the local startups get to compete on a level -playing-field with global operators.

It’s now or never 

As Sri Lanka is in the middle of dealing with the IMF in the restructuring of its loans and putting its economy in order, we can look to the Australian government to tell us how to make this transition successful and create laws similar to the Multinational Anti Avoidance Law. Currently every rupee we can gather as taxes has become important for the survival of the economy, and I’m sure as many foreign governments around the world have gathered to help our island nation we can look upon help from the Australian authorities in finding a solution to the taxation of these global digital giants.

While globalisation has presented great opportunities to flatten the earth, creating new opportunities for entrepreneurs who want to become trailblazers can bring disruption. However, this disruption can be made good, only if we know how to manage it. Sadly, countries like ours are still stuck within an old system i.e. economies prior to the digital disruption. It is this mismatch that is causing the pain points today. The time has come for us to change and embrace the digital economy in all its fullness and make it work for us. This means our fiscal and monetary policies have to be aligned and tuned, not only to manage the revenues and tax liabilities of local enterprises, but also to bring foreign companies who operate within our borders into a rationalised system that supports our economy.

(The writer, startup entrepreneur, Founder CEO of PickMe and a Past President of the Digital Chapter of FITIS, is a driving force in technopreneurship in Sri Lanka. He was instrumental in the launch of several local e-commerce companies. Under his leadership, PickMe’s technology driven platform has changed the transport and food delivery industry in the country, becoming the leading local enterprise of its kind with a sizable market share. His vision is to expand PickMe’s services across the world and to drive the company toward becoming the country’s first Soonicorn.)